Debt reduction

Helene Mueller
eCollect support team

Debt reduction is the process of decrementing the total amount of a delinquent payment, also known as bad debt. It represents a successful approach towards helping a subject of debt to clear their defaults easier and in a more convenient way. As today a lot of consumers experience difficulties in repaying the monetary obligations they owe to creditors, such plans for reducing debts become a very effective way of clearing not only individual but also business liabilities. Debt reduction as a definition is also known under the term debt relief (for UK and Wales) and represents the process of balancing consumer’s expenditures. The main strategies and methods for reducing a default are: reorganisation of consumer debts (changing liabilities’ contract terms and conditions) and refinancing (acquiring funds for a new loan to clear all existing old debts). The general idea of this financial approach is to reposition and alter debtor’s past-due amounts in order to provide the individual in debt with a more convenient outcome for repaying their liabilities.

Debt reduction plans

Debt reduction plans tend to improve consumer’s debt position and facilitate their financial condition. Companies, which offer debt diminution services, usually act on behalf of the debtor and are averse to negotiate with the original lenders. These institutions are independently operating and can be debt buyers, debt solicitors or other debt management companies. Organisations, which act in mutual interest, but represent the creditor, are generally first-party or third-party debt collection agencies. First party DCAs (Debt Collection Agencies) are part of lender’s organisation and third-party collectors are private firms, hired by lenders but not involved in the mutual contract between creditor and debtor.

Financial plans for reducing debt amounts are beneficial for both sides- lender and consumer. Sometimes the debtor does not pay the liability towards the creditor not because he is not willing to perform such actions, but because he does not possess pecuniary resources to clear their monetary obligations. In such case, debt reduction plans are suitable, as they assist the consumer not only in a financial way but also in psychological. When a debtor cannot afford to cover the debt requirements anymore, it is better for the creditor to offer reduction debt plans, rather than wait for the individual to file bankruptcy. If a subject in debt declares insolvency, the lender will not be able to collect their debts, and this action will severely affect consumer’s financial and credit profile. Therefore it is more convenient for both sides to benefit from debt reduction plans.

Debt diminishment generally includes an agreement between two parties (first party- creditor and second party- borrower) for implementation of changes in the original debt contract in debtor’s favour. In this way, the consumer receives more acceptable debt repayment terms and is able to cover the default’s requirements. Such plans not only help consumers get out of the debt situation but also train them how to handle their finances and how to avoid falling into debt in future.

Debt reduction methods vary and include different repayment options for the consumer: reduction or even freeze of additional charges and interest fees, addressed to the debtor; substituting debtor’s monthly payments with only one single transaction or reducing monthly interests. Companies, offering these reimbursement options can even negotiate with the creditor, procuring decrease of the total debt amount. In such cases, the lender might agree to cut part of the default sum and sometimes the new delinquent obligation can become up to 30% less than the original sum.

Debt relief & debt relief orders

In UK and Wales, there is another alternative of bankruptcy called debt relief, which is now included in other countries’ legislation laws, like the U.S. It is used for partial forgiveness of a debt or even full clearance of a default amount. It can also implement freeze or decrease of interest or debt growth of individual and even commercial liabilities. This type of debt reduction includes debt relief orders as well, which are governed by the UK’s TCEA 2007 (Tribunals, Courts and Enforcement Act 2007).

While a debt relief can be performed by the creditor himself, demonstrating their goodwill to forgive part of debtor’s monetary obligations towards him, the DRO (Debt Relief Order) can be filed only by high court. As a debt relief order pardons the full amount of a default, such action will not be supported by a lender. Although applying for a DRO might be tempting for debtors, the consumers should bear in mind that if they have been qualified for such order, they will have difficulties in future such as: starting a business, borrowing forthcoming loans, etc. Some banks will even decline to open a consumer bank account after a debt relief order has been granted to him.

Therefore debt relief is more appropriate and less risky option for a subject of debt. If the lender is willing to forgive part of consumer’s debt, or he agrees to change the contract conditions with more convenient terms for the debtor, an individual will benefit more from a debt relief, rather than from a DRO.

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